It is well known that the economic bubble was inflated by borrowed money, largely in the private sector. What is largely being ignored is that the total economy, public and private sector, is still being financed from abroad.
Ireland has successfully managed a trade surplus in our recent history, exporting more than we import. We have had a steady income. However, for most of the 21st Century we have shown a Current Account deficit. But why is this important? The Current Account in the National Accounts in many ways is similar to the current account a private citizen has in a bank (it is complicated in that it measures flows rather than stocks). It measures the day to day items of the national economy. It includes our trade balance, but crucially for Ireland, it includes some of our day to day expenses in the global economy. Each quarter the Irish economy must send money abroad to pay interest bills and the profits to multinationals. Given our liabilities, Ireland has to run very fast to stay still. Even having a trade surplus of €10 billion may not be enough push us back in the black.
Though the fiscal deficit is important, the Current Account serves as the bottom line for the economy as a whole. If we want to pay back our private sector debt (such as in Anglo or AIB) without just lumping it onto the National Debt, we must show a Current Account surplus.
What can be done?
It is inevitable that our debt overhang will resolve itself eventually, but as with everything in economics there are choice as to how to deal with the issue. Continuing with government policy will lead to debts being resolved through bankruptcy.
The most obvious way to reduce out international liabilities would have been to allow private sector debt stay private, and allow the bank bondholders take a hit. This would have been the correct thing to do. Unfortunately this is getting more and more difficult to do as the Government added private debt to the public debt.
We can increase exports. Unfortunately this is difficult, though not impossible. We cannot change demand from abroad but we can make ourselves more competitive.
One suggested way is to lower wages. However how would this benefit the current account? It might increase inward investment in the medium term, but as wage rates are already competitive it is unlikely it would have much of an effect. Also, as our export sector is dominated by multinationals cutting wages would simply increase the profits that are sent abroad, so a wage cut could actually harm our Current Account position. Alternatively we could try reduce non-wage costs by investing in public infrastructure.
We can reduce imports. This is something we have far more control over. One possible way is through massive Government cut backs to kill off domestic demand for imports. This is a strategy that was pursued by the IMF in South America, but they have moved away from this. The social consequences are too severe. Also a social wasteland does not make for a good export platform, so such a tactic could also reduce exports, and not improve the Current Account balance. As most government spending is done domenstically. There is some leakage abroad, but government spending can be targetted in a way to minimise this.
The government could look at which income groups spend the most on imports and increase their income tax rather than that of other groups. Also Ireland imports a disproportionate amount of goods, mainly due to our dependence on foreign energy. Investing in alternative energy is a good substitute, but also the simpler solution of public transport and cycle lanes would reduce the amount of fuel we import.
Finally we can reduce capital outflows and have one big inflow. Repatriating the National Pension Reserve Fund would be the obvious inflow. But what of outflows? Saving does not always equal investment. We should look at which income groups save their money abroad and tax them more. This will help to keep money in the domestic economy, and reduce our external liabilities.
It may be argued that this policy is protectionist, but we simply cannot afford to keep importing at the rate we have been.
14 comments:
"We should look at which income groups save their money abroad and tax them more. This will help to keep money in the domestic economy, and reduce our external liabilities."
You mean we should have tax incentives for people investing in Ireland?
What do you have in mind? Everything is of course limited by EU law.
Certain income groups are more inclined to save money abroad, so if they faced higher tax they would have less money to send abroad. This wouldn't be affected by EU competition law.
Except that saving money abroad or spending it on imports doesn't break cleanly along income lines.
On the saving side, it actually cleaves more on age bracket. High earning 30-somethings are likely to have little surplus after massive mortgage & childcare costs are taken into account. Whereas older people with little in the way of debt, children already reared and only a modest lifestyle to support are much bigger savers.
You might as well suggest we should discourage smoking by imposing a new income tax on lower earners (as they have a disproportionate tendency to smoke).
Or how about we cut down on the amount of money spent by Irish people summering in the south of France by cutting public service pensions? (Seeing as retired public servants are more likely than average to spend their pensions in the Dordogne region).
If you want to discourage some economically harmful activity, you must impose the tax the activity itself.
Not on the arbitrary group of people with a higher tendency to engage in that activity.
@ Anonymous
I don't know where you get the notion that more retired public servants take their holidays abroad. I doubt anyone collects such data. But its probably fair to say that pensioners on higher incomes go abroad more often.
You have a point about age groups, but I would say the driving factor there is wealth. The older people you describe are wealthier because they didn't get the boom time mortgage. If someone has children is irrelevant to the argument, they have tax credits to allow for that.
Normally I would want one instrument per target, so target smoking with tax on cigarettes. We can't stop people sending money abroad due to EU rules (though the pension system subsidises sending the money abroad, and we could stop doing that). However, do you disagree that what I propose would help the current account?
To be honest I think the fundamental driver of the boom/bust was income and wealth inequality, which then has manifested itself in terms of excess borrowing and a current account deficit. This is why I think targeting these fundamental drivers, rather than imports/capital outflows directly is the appropriate policy.
I don't know where you get the notion that more retired public servants take their holidays abroad.
Not just take their holidays abroad, more like spend the entire summer in their foreign property. Take yourself over the Dordogne next summer, and I guarantee you 90% of the Irish people you'll meet will be retired public servants. Many if not most of them will be younger than 65 having taken early retirement.
If someone has children is irrelevant to the argument, they have tax credits to allow for that.
Irrelevant to the argument???!! Have you any idea how much childcare costs?
Oh, and can you point me at some information on those child tax credits of which you speak? Forgetful old me, I haven't bothered to claim them for any of my three children. That could of course be because such credits only exist in your imagination.
However, do you disagree that what I propose would help the current account?
No, it will simply punish people for happening to be in same income bracket as some other folks who save their money abroad.
This is why I think targeting these fundamental drivers
But you're not targeting any fundamental drivers, rather you're suggesting a collective punishment for certain income groups for the perfectly lawful actions of some of their number.
How about requiring that public service pensioners collect the OAP component of their pension (i.e. the first 230 euros a week) in person at a post office, in the same way that dole recipients are forced to do in order to ensure they are constantly in the country. Does that seem fair to you?
Pensioners can't be forced to collect their pension at the post office, EU rules. (Anyway its not the same as the dole as they don't have to prove they are available for work).
You should check yourself for what ever you are entitled to regarding reliefs, tax credits and so on that would apply to the household you described. Children's allowance is also a tool to deal with such issues. If you want to reform the tax system to better account for the costs faced by working families with children fair enough.
I don't consider progressive taxation to be a form of collective punishment. Fiscal policy is a tool that is being used to address our economic problems.
Why would my proposals not improve the current account?
I am the first anonymous.
Obviously what you are proposing is tax incentives for the wealthy to invest in Ireland rather than investing abroad?
If you are proposing to simply tax wealthy people all that will happen is that the wealth will be moved offshore. Clearly that is exactly the opposite of what you meant.
I can't see why there would be any particular difficulty as regards EU law. There have been tax incentives for property for years and they never complained.
Middle earning people are more likely to invest abroad through something like a PRSA or other anaged pension fund. The more wealthy are more likely to invest in riskier less diversified local projects. The reason is that wealthier people have more capacity for risk.
@ Anonymous
If you can suggest such a scheme I 'd be happy to give my opinion on it.
The most obvious way to promote home investment would be to repatriate the national pension reserve of course.
For instance, tax relief for amounts invested by individuals in broadband fiber infrastructure projects, with matching finance to be provided by banks.
The same could be done for public transport schemes. These are just two examples.
To be honest I'd prefer a direct subsidy to a tax break. What I dislike about tax-incentives is it allows the government to claim they are cost free. It hides the true cost from the voters. But with a direct subsidy you know exactly the cost.
So for example we could say that for every €5 invested in broadband the government will give €1, or something like that.
With a tax break you know too. As i understand it, you look under the 'tax expenditures' heading in the government accounts. The only problem with it is that it tends to overestimate the cost because it includes tax that would never have been remitted.
If you were to do it as you describe, it might attract foreign capital, but it will do nothing to keep the savings of Irish people invested in Ireland.
It would also put the government in the situation of having to pick winners, and it would be better to leave that to the market.
It all depends on how much you trust the civil service and government which failed to deliver broadband and landed us in a giant recession, I guess.
You should check yourself for what ever you are entitled to regarding reliefs, tax credits and so on that would apply to the household you described.
I can check until I'm blue in the face, but I'll never find a tax credit for my children, as it doesn't exist. You're probably thinking of the old children's tax-free allowance, which was abolished aeons ago.
Children's allowance is also a tool to deal with such issues.
Child benefit, to give it its correct title, comes nowhere near dealing with such issues. The monthly child benefit would buy you about 3 days worth childcare in Dublin.
I don't consider progressive taxation to be a form of collective punishment.
But you're not suggesting progressive taxation (where the rich pay relatively more).
Instead you're suggesting selective taxation (where people would pay more by dint of their income falling into a bracket within which those earning similar amounts have a higher tendency to engage in harmful economically activities).
Hence the innocent (who are not saving aboard or buying lots of imports) would be punished for the activities of others who happen to earn a similar salary.
Why would my proposals not improve the current account?
Because it is the bluntest of blunt instruments that you suggest, a nuke as opposed to a scalpel. The intended side-effects are likely to be massive.
Child benefit and tax credits are tools to deal with the issues you raised. As I'm talking about altering taxation there is no reason why tax credits couldn't be adjusted too. It was a blog post dealing with general issues, not an in depth report on taxation.
Hence the innocent (who are not saving aboard or buying lots of imports) would be punished for the activities of others who happen to earn a similar salary.
I don't consider people who buy imports to be guilty of something. However my proposals would improve the current account as richer people spend more on imports, and raise much needed tax revenue.
richer people spend more on imports
Well, poorer people tend to spend more on illegal intravenous drugs. Money that ends up in Spain and Holland and Afghanistan. Should we impose a tax on their income bracket for this reason?
The motivation for imposing a tax should relate only to ability to pay, not to any activities that are more prevalent in any particular income bracket. Otherwise the people not engaging in those activities end up suffering as a result of their peer's behaviour.
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